Switzerland: The BVG generation
The BVG/LPP law of 1985 introduced mandatory workplace pensions in Switzerland. Looking back over the last 25 years, IPE questioned five industry figures
1-Have Swiss pension funds succeeded in the aims that were set out in the 1985 BVG/LPP legislation?
2-Are all Swiss trustees fit to understand the challenges and exploit the opportunities of the modern investment world?
3-Are there too many pension funds in Switzerland?
4-Does systemic underfunding of public pension funds represent a future crisis?
President, Swiss Pension Fund Association (ASIP),
1. The aim of 60% final salary coverage by the BVG and the first pillar AHV/AVS was based on the idea that interest rates would be on a par with the rise in salaries. In fact, since 1985, interest rates have exceeded growth in salaries with a real interest rate of 1.6%. While a complete revision of the law - which was scheduled for 10 years later - only took place in 2005, the full portability of pensions was already introduced in 1995. Therefore, in terms of performance goals and continuous development, the BVG has achieved its targets.
Initially designed to be a minimum framework, the BVG progressively started to regulate more and more areas, thereby significantly restricting pension funds' freedom of decision taking and increasing their costs. More transparency is generally welcomed but not to the benefit of rising costs.
2. Following the 2005 BVG review, regulations required the further education of the Stiftungsräte, the pension fund boards. But it is not the task of a Stiftungsrat to understand every single investment vehicle in-depth. It only needs to understand the fundamental risk/return characteristics of the instruments, and for these purposes they are well equipped.
3. In the early 1980s, Switzerland boasted around 17,900 Pensionskassen. By 1987 this number had already fallen to 15,179 and, by the end of 2008, it stood at 2,435. Driven by the desire to save costs, this concentration process is expected to continue although, of course, not at a linear pace. It is difficult to assess whether there are still too many pension funds and it would be wrong for the regulator to dictate a number.
4. On average, the levels of underfunding substantially improved during 2009 including for public pension funds. The Swiss parliament is currently discussing a new draft proposal that would address their situation. The intention is to improve their funding level fairly over the next 40 years to at least 80%. Due to the relatively good financial position of Switzerland compared to other European countries, it does not represent a possible future crisis.
Pension fund manager,
Pension Fund of the Hewlett-Packard Companies
1. The BVG/LPP has achieved the minimum targets it set out to achieve in 1985. A problem, however, is the long-term funding of the system in the future. For employees in a pension fund exceeding the mandatory benefits, this is a minor matter though as for normal earners, only around a third of the final pension will stem from the BVG.
2. A common rule says only to invest in what you understand, which is exactly what we do in our cash balance pension fund. Backed by a guarantee from our parent company, the bulk of the pension fund is invested in equities, which is complemented by government bonds and real estate. For complexity reasons the pension fund is not invested in alternative investments. Following the last asset liability management study in 2007, we analysed private equity in depth. The final decision not to invest in private equity was made by the board of trustees with the help of an investment consultant.
3. In the past, Swiss pension funds were very dependent on the employer, who used the pension fund arrangements to increase the loyalty of his employees towards the company. However, as this no longer is a priority for most employers, the trend of mergers between pension funds is set to continue.
4. While public funding might present a problem for public pension funds, it is not an issue for us as we are backed by the employer's guarantee. The parent company will top up the pension fund finances in case of underfunding and, whenever the markets recover, its contributions will be held as corporate contribution reserves. Two debates are emerging now: to either limit Swiss occupational pensions with their minimum guarantee to a long-term affordable minimum or to guarantee a minimum pension and make any additional pension dependent from the investment return.
CIO, asset allocation,
1. The objective of the BVG/LPP regulation was to set up a system where both first and second pillar combined would offer a guarantee of at least 60% of the final salary in retirement - an objective that, taking into account growth in productivity and real wages, has been met.
However, the implementation of the law is also faced with two controversial issues, but which are not specific to Swiss regulation. One is that in periods of crisis the regulator may be prompted to ask pension funds to take pro-cyclical steps, meaning that underfunded funds could be required to sell their assets at the worst possible time. Secondly, the regulation of the investment universe through maximum investment limits does not take into consideration the different levels of risks and volatility at various times in the financial cycle.
2. The new BVV2/OPP2 regulations in particular - an ordinance of the BVG/LPP law - put a lot of autonomy in the hands of pension fund boards. The question is whether the boards have the means to use this autonomy in an efficient way, which is linked to the critical average size of Swiss pension funds rather than their technical skills and knowledge.
3. Despite a sharp decline in the number of Swiss pension funds to below 2,500, the average size of pension funds in Switzerland is still lower than in many other European countries. This means that 90% of pension funds still manage less than 20% of the assets and a lot of them are too small to benefit from economics of scale by themselves. Therefore I expect the umbrella structure, which offers centralised management solutions to de-centralised pension funds, to expand.
4. In contrast to most of the private funds, public pension funds in Switzerland are to a large extent underfunded. But although for some the level of underfunding is significant, we must bear in mind that the necessity of being fully funded only applies to the medium to long term, not to the short term. We should not exaggerate the situation, as it is much more progressive to gradually increase their funding.
Head, institutional clients,
1. The Swiss system - with the exception of the first pillar AHV/AVS - is based on capital funding. Of course it therefore depends on developments in capital markets but the system has proven itself and stood the test of time. One of its characteristics is that its executive bodies, such as pension fund boards, are required to undergo constant professionalisation and education. This meant that the system moved from an absolutely safe investment operation to the financial managerial responsibility of the relevant bodies.
2. The Swiss pension fund landscape is very heterogeneous. Very large pension funds with big resources are better equipped to understand the challenges and exploit the opportunities than their smaller counterparts. However, in the end it is all down to the expertise of the personnel.
3. It is not a question of quantity but of quality. A well-managed pension fund has a right to exist. Rising complexities in administration and responsibility have led to the liquidation of previously autonomous pension funds and their outsourcing to a Sammelstiftung or an insurer. Whether the trend of pension fund mergers is to continue depends on the development of the capital markets. Often companies start thinking of creating their own autonomous pension funds after a few good years in the capital markets because they believe they could have achieved a higher return. However, the other side of the coin is that volatile markets often drive pension funds to join a Sammelstiftung.
4. The underfunding of public pension funds is a political hot potato. I do not think it will lead to a crisis in the future because, although the pension funds officially need to have a funding ratio of 100%, there is room for manoeuvre, especially in times of crisis. But the current level of benefits Swiss pension funds have to pay, which is steered by the conversion rate (Umwandlungssatz), could become a problem. Nevertheless, the Swiss showed recently at the poll booths that they were not yet ready for cuts, which are an economic necessity to maintain the system.
CEO Swisscanto Vorsorge
1. The BVG/LPP law was created on the basis that, together with the first pillar, it should enable retirees to maintain their lifestyle and cover around 60% of their final salary. Up to a salary of CHF80-90,000 (€57-64,000) this has been achieved. It was never the aim to generate 60% of the last salary for high earning individuals.
Initially, the BVG was not perfect. However, the legislator has since added amendments. In 1995, for example, it introduced full portability of contributions paid by the employer as well as the employee. In 2005, tax deductibility for pension contributions was restricted to salaries below a certain ceiling. A third amendment led to the split of occupational pensions in divorce cases according to the length of marriage.
2. Swiss pension fund boards or Stiftungsräte consist equally of employer and employee representatives, so they are not always equipped with the right know-how. But Swiss law requires them to undergo educational training for pension fund purposes on a regular, at least annual, basis.
However, not every pension fund board can judge whether a modern investment vehicle will be beneficial to the pension fund. It will then seek advice from professional advisers.
3. On average, 120, especially smaller, private Pensionskassen have disappeared in recent years every year, a trend that I expect to continue, albeit at a slower pace, as more companies consolidate. New pension fund formations on the other hand are rare. Smaller pension funds are more likely to join a Sammelstiftung, an open multi-employer foundation, because they suffer resource constraints with regard to administration and investment strategy.
4. Due to the collapse of the financial markets, around 50% of pension funds in Switzerland fell victim to underfunding in 2008. Lessons have been learnt and there is now a renewed focus on pension fund reserves to help buffer fluctuations in the markets. According to a Swisscanto survey, the average Swiss reserve, which currently stands at around 4-5%, should amount to 15% of total assets under management.